Fundamental vs. Technical Analysis: Understanding the Differences


Fundamental Analysis examines all of the factors that impact the price of a company’s stock. These factors include the recent news financial statements, management structure, industry, and more. The goal is to determine the intrinsic value of the firm and ascertain if the asset is over or under-priced. Most often used by investors looking for longer-term positions.

Technical analysis employs price charts, patterns, indicators, and trends to forecast an asset’s price action in the near to distant future. Traders partake in this type of analysis mostly, as it provides a good read on the current price action.

Stock prices constantly change throughout trading sessions, making understanding the coming price action a key to profits. Traders use both types of analysis to find trends and predict price movements for an asset in the future.

 

BASIS FOR COMPARISON FUNDAMENTAL ANALYSIS TECHNICAL ANALYSIS
Meaning Fundamental Analysis is the practice of analyzing an asset to determine its intrinsic value of the stock. Technical analysis is a method of determining the stock’s future price using charts to identify the patterns and trends.
Relevant for Long term investments Short term investments
Function Investing Trading
Objective To identify the intrinsic value of the stock. To identify the right time to enter or exit the market.
Decision making Decisions are based on the information available and statistics evaluated. Decisions are based on market trends and prices of stock.
Focuses on Both Past and Present data. Past data only.
Form of data Economic reports, news events, and industry statistics. Chart Analysis
Future prices Predicted on the basis of past and present performance and profitability of the company. Predicted on the basis of charts and indicators.
Type of trader Long-term position trader. Swing trader and short-term day trader.
Source: keydifferences.com

 

What Is Fundamental Analysis?

Fundamental analysis is a method of finding an asset’s intrinsic value through economic and financial components. There are several factors fundamental analysts focus on, macroeconomic factors including the state of the economy and industry, while also accounting for micro factors like company management structures and philosophies.

The analyst’s goal is to determine a price they can compare the asset’s current value against to find whether it is over or undervalued.

Key Takeaways

  • Fundamental analysis determines a stock’s real or “fair market” value.
  • Fundamental analysts hope to find stocks currently trading at higher or lower prices than their real value.
  • An asset is undervalued when the fair market value is higher than the market price – this is when a buy is recommended.

 

Understanding Fundamental Analysis

Determining whether an asset is undervalued or overvalued in the market is the point of analysis. Fundamental analysis is typically a macro to micro process to choose the most mispriced assets.

From largest to smallest, analysts look at the current economic situation, then the industry’s strength, before finally focusing on a company’s performance to find its fair market value.

Fundamental analysis utilizes public data to evaluate a stock or any other type of asset. An investor can perform fundamental analysis on an asset’s value by looking at revenues, earnings, future growth potential, return on equity, profit margins, and other data to define a company’s fair market value and potential for future growth. This data is available in a company’s financial statements as required by trading commissions.

 

Quantitative and Qualitative Fundamental Analysis

The “fundamentals” of a company refer to a multitude of factors, anything tied to the company’s economic well-being, including market share, revenue, profits, management structure, and reputation.

Quantitative and qualitative are the two categories that encompass all fundamental factors. Defined as:

  • Quantitative — “relating to, measuring, or measured by the quantity of something rather than its quality.”
  • Qualitative — “relating to, measuring, or measured by the quality of something rather than its quantity.”

The two are opposites. Quantitative looks at the numbers, the measurable factors of a company; revenue, assets, profit, etc. Qualitative focuses on the intangibles, brand recognition, patents, influential executives, etc.

Both qualitative and quantitative analyses are equally useful in their own respects, which is why analysts often consider them together before making decisions.

 

What Is Technical Analysis?

Technical analysis studies statistical trends in trading activity, such as price movement and volume, to evaluate and identify trading opportunities.

Fundamental analysis seeks to determine the value of an asset through its sales and earnings, while technical analysis centers around the study of price action and volume.

Technical analysis tools like indicators and oscillators are used to examine the effects of supply and demand on an asset, and their impact on changes in implied volatility, price, and volume. This type of analysis is often harnessed for short-term trading signals from various charting tools.

Technical analysis can be used on any stocks, futures, commodities, fixed-income, currencies, and other assets with historical trading data. In this article, we’ll look at a couple of examples of using technical analysis with indicators and oscillators. This type of analysis is most often used in forex and commodities trading.

Key Takeaways

  • Technical analysis studies statistical trends found in trading activity, such as price movement and volume, to evaluate and identify trading opportunities.
  • Technical analysts believe past trading activity and price changes of an asset can be valuable indicators of the asset’s future price movements.

 

The Basics of Technical Analysis

Charles Dow is the grandfather of technical analysis with Dow theory, which was followed and improved upon by many researchers helping to solidify the core of the concept. Technical analysis today is drastically different than when it was first introduced in the 1800s, now including hundreds of patterns, signals, and tools.

All technical analysis operates with the implied belief that previous price action and trading activity of an asset can relay valuable information about future price changes with the right strategy.

Professional analysts use technical analysis in conjunction with fundamental analysis. Day traders may make trading decisions only utilizing the charts and tools. Finding the right balance depends on your trading goals and strategy.

 

The Underlying Assumptions of Technical Analysis

Technical analysis relays on the notion that:

  1. Markets are efficient with values, meaning an asset’s current value represents all factors that could influence an asset’s price, but
  2. Even market price movements that appear to move randomly are, in fact, identifiable trends and patterns that repeat over time.

Where fundamental analysis uses a company’s financial statements to determine the fair value of the business, technical analysis assumes that an asset’s price always reflects all publicly-available information. Therefore, it centers on the statistical analysis of price action while attempting to understand the market sentiment behind price trends through patterns and trends.

Charles Dow released editorials explaining his technical analysis theory. These writings included the two basic assumptions mentioned above that have formed the framework for technical analysis trading.

Today, professional analysts typically accept three general assumptions of the discipline:

1. The Market Discounts Everything

Essentially the market has already taken all of the available information for the company and has priced it accordingly. This idea is paralleled by the Efficient Market Hypothesis (EMH) that arrives at a similar conclusion—leaving technical analysts to see an asset’s price action as a result of supply and demand.

2. Prices Move in Trends

Most technical trading strategies are based on the assumption that prices will continue with the trend rather than move erratically. Similar to the law of motion, an object in motion will remain in motion unless acted upon by an external force; however, the push and pull of supply and demand are constant. Therefore a greater force is needed to change course.

3. History Tends to Repeat Itself

A common philosophy, believed by history teachers everywhere. The repetition found in price movements has been attributed to market psychology. The sentiments that move prices are excitement and fear can be predictable. Harnessing that predictability is the center of over 100 years of technical analysis. Many of the same patterns are taught and used today as they were all that time ago because people do not change, and it is people and their emotions that move prices.

The market discounts everything, prices move in trends, and history tends to repeat itself, the three pillars of modern technical analysis. Using them alone will not work for all traders. However, with the right strategy, these principles can lead to success.

 

Basic Technical Analysis with Indicators and Oscillators

Indicators and oscillators are mathematical calculations that use price, volume, and other market metrics to forecast the trends and direction of an asset. Traders use them to help with technical analysis, to determine market trends, reversals, entry and exit points, as well as whether to buy or sell.

Combined with a trading strategy these tools help increase a traders success rate.

First, the SMA or Simple Moving Average. This indicator is often used as an area of interest for traders. Meaning it signals a reversal when prices go from above to below the line or vice-versa. The line is determined by calculating the average of an asset’s price using the previous ten candles.

How to use the SMA

When an asset’s price crosses the indicator line upwards from below, it signals a likely rise and shifts to an upward trend. When the price crosses the indicator from above, it signals a fall

Next, the RSI or Relative Strength Index, a momentum oscillator. Traders rely on this indicator to assist them in determining whether an asset is overbought or oversold indicating a coming trend reversal.

It is a single line floating between 0 and 100, this indicator shows is being oversold or overbought as it approaches its respective extremes. As the line approaches 100 the more likely the instrument is to be overbought, and conversely, when the line nears 0 it is likely oversold. If an asset is overbought or oversold signaling an end of the current trend.

How to use RSI

Generally, the lines of importance are set at 30% and 70% shown by the green and orange lines. Though the range is 0 to 100% these guides help traders track the progress simply. If the line crosses either 30% or 70% the reversal is signaled when it crosses back over the line.

There are many other indicators and oscillators that are available for traders to use on the Olymp Trade platform, but these two give a good introduction to what indicators and oscillators are and how to use them to make your trading more successful.

 

The Best of Both Worlds

In this section, we will look at the most used type of strategy that combines fundamental and technical analysis methods. Together they provide more information than alone, giving traders additional insights.

Volume Trends

A popular way to gauge market sentiment is through traded volume. Traders can use this information to infer whether their ideas of the trend are echoed in the larger trading community. No individual trader can’t have the whole picture of what is happening in the market; that is why many trust the volume to tell them more.

Large spikes suggest something has happened to attract the attention of traders and that shares are being accumulated (bought) or distributed (sold). A sudden drop in volume suggests that traders are losing interest and a reversal is more likely.

Volume indicators can help confirm whether other traders have the same outlook on an asset as you. Traders utilizing these types of strategies watch for the volume to increase while a budding trend gains momentum.

Using fundamental analysis to find an asset trading above or below the fair market value and applying volume indicators to the chart, or establishing a trend and looking up the cause of the spike in trading volume. Volume Trends are one of the many types of strategies that combine the two types of analysis.

 

Combine to Conquer

Fundamental and Technical analyses are different yet equally important in the world of finance. Fundamental analysis is mostly used to guide longer-term investments, while technical analysis lends itself to the short-term.

For traders on the Olymp Trade platform combining the two will be most fruitful. Technical analysis helps spot the trend, and fundamentals explain why it is taking place. Determining which strategy is best suited for your goals will establish the right blend of the two for your goals and risk tolerance.


Risk warning:

The information provided does not constitute a recommendation to carry out transactions. When using this information, you are solely responsible for your decisions and assume all risks associated with the financial result of such transactions.

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